Two Schools and the Path to the Steady State

by Eric Zencey

All of economics is divided into two schools:  steady state theory and infinite planet theory.  They can’t both be right.  You’d think the choice between them would be obvious, but infinite planet theory still holds sway in classrooms and in the halls of power where policy is made.   Last month, though, brought a significant development:   the manager of a major hedge fund registered a carefully reasoned dissent from infinite planet theory.  And in doing so, Jeremy Grantham offered a glimpse of how and why steady state economic theory will ultimately come to prevail.

Grantham is the head of GMO LLC, a hedge fund with $100 billion under management. His latest letter to his investors was headlined “Time to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever”—a title that calls to mind the urgent warnings raised by steady-staters as far back as the 1970s.  Those warnings were dismissed by most economists as Chicken-Little fears that could safely be ignored—and the western industrial world proceeded to do just that.  Infinite planet theorists pointed to the work of Julian Simon, who argued that human ingenuity is The Ultimate Resource (as he put it in the title of a book). Since technology, a human invention, is a factor of production, and since human capacity for invention is infinite, there can be no resource limits to economic growth.  Infinity times anything is infinity, right?

You can get to that conclusion only if you ignore the laws of thermodynamics. However inventive humans have been or may yet prove to be, they’ll never invent a way around the first and second law.  You can’t make something from nothing and you can’t make nothing from something (the first law).  You can’t push a car backwards and fill the gas tank (the second).  Together these laws rule out perpetual motion, schemes in which energy is created out of nothing or recycled and used again.

In steady state theory, the economy is seen as a thermodynamic machine, drawing in matter and energy, processing them with more energy, and excreting a high entropy wake.  The economy thus has two ecological footprints:  one on the uptake and one on the discharge side.  Since both footprints land outside the abstract world of theory and in the physical reality of a finite planet, neither can increase forever.

Economists might have put these truths into practice decades ago.  Had they done so, they would have been in good company.  Physics had its thermodynamic revolution in the person of Albert Einstein, whose path from Newton to relativity began with thermodynamics, as he played out the un-mechanical implications of the second law.  (Mechanical motion is reversible; energy use is not.)  Biology was transformed in the 1920s and 1930s, as biologists saw that evolution is driven by competition for energy, which structures and maintains ecosystems—food webs—in which sunlight becomes green plant then herbivore, carnivore, detritivore.

Why, then, has the thermodynamic revolution in economics been postponed? The question will intrigue historians of the future, who will wonder at the profligacy of our culture and our cavalier disregard for ecological limit.

Part of the answer is the bet that Julian Simon made in 1980 with population activist Paul Ehrlich.  Simon maneuvered Ehrlich into wagering on the future price of any group of resources that Ehrlich cared to pick:  if Simon’s theory was right, he claimed, the prices would be lower within ten years.  Simon won.

His victory was widely taken as proof of his infinite planet theory, despite the obvious flaw in it.  The market price of any commodity is a human construct, the result of market supply and demand, not an indicator of scarcity in any absolute sense.  From a limited stock of a finite resource—oil, say—we can choose to extract the resource at a greater or lesser rate.  If the rate at which we pump oil out of the ground exceeds the rate at which demand for oil increases, the market price will fall.  This doesn’t prove that oil is plentiful, let alone infinite.  It doesn’t prove that we’ve invented our way around the laws of thermodynamics.  It merely proves that we’ve extracted oil fast enough to keep its market price from rising.

Grantham goes head-to-head with Simonism not on these theoretical grounds but with solid empirical evidence:  commodity prices are rising and aren’t likely ever to come down again.  Volatility in prices can be assessed by looking at change in terms of standard deviations from the mean:  how big, exactly, are the swings, as measured against average variability over time?  Sharp increases in the prices of significant commodities since 2002 fall well outside the standard deviation; for iron ore, the rise has been 4.9 times the standard deviation, a result that (Grantham tells us) has a one in 2.2 million chance of being “normal” variation.  More likely, it signals a new and different reality.  For coal, copper, corn, silver, sorghum, palladium, rubber, etc., the odds aren’t as long, but still pretty sizable:  one to 48,000, one to 17,000, one to fourteen- and nine- and four thousand.  This basic, deep-seated trend lies beneath the statistical noise—price spikes and troughs, including those created by speculation and subsequent “market corrections.”

Based on this analysis, and on a review of energy use that reaches back to when wood was our primary fuel, Grantham concludes that we have entered a new era:  we are on the cusp of what he calls The Great Paradigm Shift, “one of the giant inflection points in economic history”—the moment, he warns, that lies at “the beginning of the end for the heroic growth spurt in population and wealth caused by…the Hydrocarbon Revolution.”

You don’t find too many economists, let alone market analysts, reaching back to look at energy use before the era of coal.  In the infinite planet neoclassical model, anything before James Watt is quaint and distant, and everything before Adam Smith is simply darkness.  It’s true enough that steam-driven factories, embodying the division of labor that Smith celebrated, were game changers, leading to phenomenal economic growth; but you can’t see the scope of the game, or even begin to see that it has an end, unless you put those inventions into an historical and geophysical perspective that reaches back before Watt and Smith.

That’s why the Industrial Revolution is more properly called the Hydrocarbon Revolution.  In focusing on the machinery, “Industrial Revolution” leads us to think that the engine of economic growth was human invention—and thus leads to the mistaken idea that more and better invention will let us increase productivity forever.  “Hydrocarbon Revolution” makes clear that the modern economic miracle has thermodynamic roots.  Economic history changed when we began systematically to exploit a new stock of energy, the stored fossil sunlight of coal and oil, with its historically unprecedented rate of energy return on energy invested (EROI)—as high as 100:1 for oil in the early part of the twentieth century.  “Hydrocarbon Revolution” reflects the reality that the enormous productivity gains of the machine age are rooted in that very favorable EROI.  It also implicitly includes the warning that the modern economic miracle must end when this stock of thermodynamically cheap energy is used up.

The essence of steady-state thinking is that we have to shape our economy to operate on a finite planet, within a stable, sustainable budget of matter-and-energy throughput.  That throughput has to be sized so that the economy’s two footprints fit into the available ecological shoes.  Grantham has noticed that one of the shoes is pinching, and he’s begun to articulate the reasons why, to an audience highly motivated to listen.  If they heed his warning— “From now on, price pressure and shortages of resources will be a permanent feature of our lives”—the considerable engine of self-interest will be hitched to the adoption of steady state economic theory.

If practitioners adopt steady-state principles, the economists who theorize about them can’t remain far behind.

Upton Sinclair once observed, “It is difficult to get a man to understand something when his salary depends upon his not understanding it.”  In the past that logic has worked against the spread of steady-state thinking.  Now the logic has turned:  if you want to make money, you’d better acknowledge reality, including the reality that on a finite planet there are limits to growth.  To those of us concerned about the fate of a civilization that’s outgrown its ecological niche, this is a welcome development.

New Thinking on BP Spill: Declare a Holiday!

The BP spill demands a far more significant response than ongoing cleanups, unsuccessful attempts to plug the gushing oil, and desperate efforts to mitigate the multitude of impacts from the biggest oil catastrophe in U.S. history. The BP spill demands a paradigm shift in how we run our economy and carry out our governance. Historians will one day look back on this spill as the nadir of governmental regulatory performance, in which oil companies commandeered and corrupted the Interior Department oil leasing program.  So what’s the response we need to get the paradigm shift going?  How about declaring a new holiday?

Before describing this new holiday, let’s look a little more closely at the current response.  Congress is not thinking in terms of a paradigm change either in the economy or the regulatory framework. Nor is the Obama administration. They are thinking about where oil drilling is okay and where it is not. Some Republican leaders, like Representative Barton of Texas, even accused President Obama of trying to “shake down” BP.

So instead of fundamental change, the most likely Congressional response to the BP spill will be to go back and write a new liability law for oil.

Following the tragic Exxon Valdez tanker accident in Alaska in 1989, Friends of the Earth was a leader in pushing for the 1990 Oil Liability Law to help safeguard against another Exxon Valdez accident. This law put in place requirements for double-hull oil tankers and new liability ceilings. Our hope was that the 1990 law would prevent bad spills and reduce spill frequency, but given the nature of enforcement (coupled with oil company attempts to flout regulations), the law was insufficient to protect the Gulf of Mexico.

This type of legislative response is too tepid to meet the challenge. The gravity of the current BP spill is the latest manifestation of the massively polluting direction of worldwide energy growth – growth that is jeopardizing the livability of our planet.

On July 5, the New York Times reported that per capita energy consumption in China is soaring as its population seeks more and bigger cars and appliances. Given that the global population stands at 6.8 billion and is headed toward 9 to 11 billion by 2050, a paradigm shift in the basis for the world economy is necessary just to head off the many tragedies that are already occurring in connection with excessive consumption, soaring population, grotesque pollution, and the obliteration of diverse ecosystems.

The economic structure must be totally reshaped to require real cost pricing for natural resources to reflect all the external costs imposed on current and future generations and on the life-support systems of the earth. We must ask ourselves serious questions that most economists don’t want to deal with. For example, what is the real cost of coal or of oil? Why is the concept of economic growth sacrosanct?

It is not just in the energy sector that we see prices failing to reflect their ecological costs, but across the food, health, and safety spectrum. What is the real cost of our food and of the animal factory slum operations that brutalize animals and shove their health and pollution impacts off on neighboring communities? What is the real condition of our topsoil and our groundwater? What is the real index of social and economic well-being, given that GDP (gross domestic product) only measures throughput in the economy with little accounting for the future?

In particular, under a new economics there would be a shift away from oil usage because the price of gasoline at the pump would be about $9 per gallon when social and environmental costs are included, not the artificially low prices we see today.

The Center for Technology Assessment published an updated estimate showing that the real cost of gasoline at the pump is between $5.60 and $15.14 per gallon if all the hidden subsidies and serious damages caused by gasoline usage were factored in. Health damages from all the air pollution caused by motor vehicles ranges between $231.7 and $942.9 billion annually, and military protection for oil supplies ranges between $55 and $96.3 billion per year.

To move us toward bigger thinking, the United States should declare an Interdependence Day. This July Americans celebrated the 234th Independence Day with fireworks galore. But the U.S. needs more ecological awareness and recognition of our interdependence with the rest of humanity and other life on this planet. On Interdependence Day we could reflect on how much we depend on others and on our environment to support us. We are on spaceship earth together and we need a spaceship economics for us to survive over the long run, not the cowboy economics that produces boom and bust cycles with some big winners and massive numbers of losers.

The gigantic economies of the United States, China, and Europe can spread air pollution and toxins all over the earth and even affect people living in remote areas. Interdependence Day would dramatize how pollution in one area harms people’s health in other areas. It would help foster consideration of the profound changes that must follow in the aftermath of the BP spill.

The future of civilization depends on moving rapidly away from an economy that glorifies jobless growth and futureless growth to a prosperous steady state economy, an economy that tells the truth about the real cost of natural resource extraction and usage.

The stewardship aspects of the economy should appeal to all the great religions of the world, and their voices are needed to counter the disinformation campaigns of the major polluters. The BP oil disaster gives citizens the platform to speak out and demand a new economics for a clean energy future and for the well-being of humanity.